Proposed Energy Tax Is a Catch-22

ByJames M. Sheehan. James M. Sheehan is a research associate with the Competitive Enterprise Institute, a free-market think tank in Washington.March 5, 1993

THE great allure of the energy tax proposed by President Clinton is that it is supposed to improve the environment while raising revenue for the federal government. Though this appears to be a powerful justification for a new tax in tough budgetary times, its dual environmental and fiscal benefits are highly exaggerated.

The energy tax is chiefly intended to curtail industrial pollution associated with the burning of fossil fuels. In theory, it would induce polluters to incorporate the society-wide costs of pollution into their own production costs. It might serve to reduce emissions and promote energy efficiency, saving all of us money. But, for the tax to truly increase economic welfare, it must shift resources away from wasteful economic activities and toward more highly valued uses.

One target of the energy tax is potential global warming. The tax would reduce industrial emissions of carbon dioxide, which some scientists contend is contributing to a warming of the climate. Energy-tax proponents claim that society must be protected from global warming, yet some scientists suggest increased atmospheric carbon dioxide, a plant fertilizer, would be highly beneficial to agricultural productivity. If there are net benefits to society of fossil fuel use, then perhaps we should be consuming

The social effects of climate change are impossible to quantify right now, making energy-tax remedies too imprecise to be environmentally effective. Even if individuals are being harmed by carbon-dioxide emissions, the energy tax, instead of compensating them, forces them to pay more of their income to the government. Unfortunately, people are less able to cope with environmental problems when they are poorer.

Urban air quality is also mentioned as a beneficiary of reduced energy use. But the tax proposals themselves are notable for their glaring inefficiency. A broad-based national energy tax does not distinguish polluted areas from cleaner ones. Nor does it distinguish between urban and rural dwellers. Reduced energy use in Montana is unlikely to affect air quality in New York City, but residents of Montana are penalized more because they generally require more fuel for traveling.

TAX proponents complain that America is "overconsuming" energy, and the government must step in to properly calibrate the national energy meter. The United States consumes more energy than Germany or Japan. However, our spacious living quarters are more expensive to heat and our expansive countryside makes for more travel. A crowded city like New York is comparable to Japan in terms of energy efficiency, but that does not mean that rural America is inefficient. Our apparent over-consumption is due to num erous demographic, geographic, and cultural factors unrelated to efficiency.

True energy inefficiency prevailed in centrally-planned Eastern Europe, where socialist economies generally used nearly three times as much energy per dollar of gross national product (GNP) as market economies. There, statist economic policies impeded prices from communicating the relative scarcity of resources, the only true measure of their value. Only unrestricted prices can communicate information about scarcity quickly and accurately to producers and consumers. If individuals are overly wasteful, th ey will not be able to afford their consumption habits. The lesson of central planning was that government bureaucrats are technically incapable of redistributing national resources more efficiently than the market.

While touting only the hoped-for benefits, energy-tax proponents commit another fundamental economic error by failing to weigh the costs against the benefits. Many economists expect the energy tax to saddle the economy with additional inflation and unemployment. Because of higher production costs, US exports will be less competitive on world markets. Energy taxes will cause traumatic price distortions in the energy sector, leaving consumers with less disposable income. A shock to the energy industry will

reverberate throughout the economy, just as it did in the 1970s.

A sluggish economy could depress nonenergy tax revenues and necessitate higher social spending, bringing the budget deficit no closer to being balanced.

The tax system is a very blunt tool for planning national energy use. Mr. Clinton faces a Catch-22: If the tax is too broad-based, it cannot achieve its purpose; but if it is too focused, it will inflict too much economic pain. As a result, the new energy tax will not accomplish any of its objectives, economically or environmentally.